IT outsourcing is playing a larger role in enterprise IT organizations as they attempt to gain efficiencies and cut costs on a global scale. As enterprises develop their IT outsourcing and offshoring strategies, it’s critical that they craft IT outsourcing contracts that drive IT outcomes and deliver business value. In this FAQ, learn where to start when you draw up IT outsourcing contracts, how to prepare service-level agreements (SLA),which terms typical IT outsourcing contracts should have and how to make your contracts flexible documents that deliver the benefits your organization seeks. Also, consult our FAQ about getting started with IT outsourcing and offshoring.

How do you begin drawing up an IT outsourcing contract?

Never use a vendor template when you draw up an IT outsourcing contract. “They’re inherently slanted toward the vendor, and it’s going to take a lot to modify it,” said Helen Huntley, a research vice president and IT outsourcing analyst at Gartner Inc., a Stamford, Conn.-based consultancy. Instead, look to your own legal team, and don’t be afraid to turn to a third-party firm for direction. “[IT organizations] are going head to head with masters of negotiation,” she said. “If they don’t have a team with the same capability [in] understanding maturity about negotiations, they are not going to be as strong at the table.”

Take a hard look at your own procurement department before you entrust them with your IT outsourcing negotiations. Some procurement departments are very focused on cost, but that’s not necessarily the most important aspect of an IT outsourcing deal. “In outsourcing, you could be buying something more service-related and relationship-driven – it’s different than buying printers,” Huntley said.

Enterprises should consider a few main factors from the get-go, said Tom Lang, a partner and managing director at TPI, a global sourcing advisory firm based in Houston.

“We always say, there are three legs on a stool: price, productivity factor and SLAs,” Lang said, calling pricing “the most complicated area of these deals.” Pricing algorithms, for example, are quite complex, and can be based on the number of quality, full-time employees devoted to a deal; the workload output; or other factors. As for productivity, it’s important to measure your own organization’s productivity levels before both parties can agree on the service levels the outsourcer is expected to maintain.

How do you craft SLAs in an IT outsourcing contract?

Every contract should have performance metrics that prove the vendor is living up to the terms of the agreement. “Never sign a deal without SLAs, or with to-be-determined metrics,” Huntley said. “If you don’t have penalties associated with the SLAs, then they’re just objectives. How will you hold [the vendor's] feet to the fire?”

However, Christine Ferrusi Ross, a vice president and research director at Forrester Research Inc., a Cambridge, Mass., technology and market research company, said you shouldn’t have too many SLAs.

“It’s like a pilot’s dashboard — if there are too many blinking lights at once, you’re not sure where you should be looking,” Ferrusi Ross said. Perhaps an enterprise must accept that it doesn’t need 24-hour response times from its helpdesk, for instance.

Clients often get frustrated when their outsourcer is meeting their SLA but they’re still not happy with the service levels delivered, Ferrusi Ross said. As such, clients need to understand what the SLA actually accomplishes. “It keeps you from paying for higher SLAs than you actually need,” she said. “A lot of clients struggle in this sense. Everyone thinks higher SLAs are better, but they don’t quite understand the financial implications of what it means in dollars and cents.”

As a general rule, SLAs should include some numerical objectives and a clear statement of the end results expected. It’s also important that the people responsible for the performance being measured are the ones involved in the development of the metric. “It’s easy to get lost in the nitty-gritty details” of performance management, Ferrusi Ross said.

In all cases, start by establishing business goals, then outsourcing goals and last, the terms of the SLA. “Make sure everything rolls up to an operational benefit,” Ferrusi Ross said.

Interestingly, Ferrusi Ross said she has one client who doesn’t believe in penalties for missing SLAs, but offers bonuses for exceeding them. “It’s a fascinating idea that changes the provider mind-set,” she said.

SLAs should not be about trying to get money back from suppliers, TPI’s Lang said. If a supplier has a problem, it should have a certain time frame – perhaps several months – to get back in the client’s good graces, he said. That encourages both sides to work toward achievable SLAs that benefit the business, he added.

“Most of the contract is kind of like a prenuptial agreement before a marriage,” Lang said. “You spend all the time working on how it’s going to work if it’s not working.”

One of the most critical terms a client should seek is the outsourcer’s demonstration of progress, which can then cycle back to clients. “As we set the baseline for SLAs that are critical, we’ll ask that the contract include continuous improvement,” Lang said.

How long are the terms of a typical IT outsourcing contract?

“When I first got involved, you never saw a deal of less than 10 years. Now the average is less than five,” Lang said. For a major asset, however, such as outsourcing a data center, he recommends a five-year deal at the minimum.

For application deals, Gartner is seeing shorter IT outsourcing terms, usually two- to three-year contracts, Huntley said. Infrastructure deals are tending to run longer, between three and five years, with the length of the term being somewhat dictated by the work being provided. Data center services are longer term, because they tend to represent more mature service delivery. In signing longer-term deals, it’s extremely important to establish a benchmarking process that will make sure cost rates continue to match changing market values. Organizations “need to give themselves cost-change provisions so rates come within the market bands,” she said.

How can an IT outsourcing contract be flexible?

“Flexibility means different things to different people,” Huntley said. The definition depends on what your organization is looking for. Flexibility can mean shorter terms, or having your service levels reviewed on a more timely basis. It can mean crafting provisions so that your baseline can be adjusted at certain intervals, or changing your service delivery model to incorporate emerging technologies, such as cloud computing.

Flexibility also includes crafting proper out-clauses. “Termination language has to be very clear,” Huntley said, and it should include three provisions: one for cause, if the outsourcer materially breaches the contract; one for convenience, if your own business needs change (you may have to pay some early termination fees); and one for change of control to another provider.

“We see a lot of consolidation in the market, so if your vendor were to be acquired, you would have the right to renegotiate with that vendor if they have a controlling interest you no longer want,” Huntley said.

This goes for bankruptcies as well, or improper financial reporting, which would allow you to sever ties, such as was the case with Satyam Computer Services Ltd., Huntley said.